Opinion: If deflation is so terrible, why are Spain, Greece growing?

MatthewLynn

Prices are starting to fall across the European continent. Mass unemployment, and a grinding recession are forcing companies with too much capacity to charge less for their products. Company profits will soon be collapsing, while government debt ratios threaten to spiral out of control.

But here’s a puzzle. The two countries with the worst deflation in Europe are Greece and Spain. And two of the countries with the best growth? Funnily enough, that also happens to be Greece and Spain. So if deflation is so terrible, how come those two are recovering fastest?

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The answer is that deflation is not nearly as bad as it sometimes made out to be by mainstream economists. The real problem is debt. But if that is true, perhaps the eurozone would be better off trying to fix its debt crisis than campaigning to raise prices — especially as it probably won’t have much success with that anyway.

There is no question that the eurozone is sliding inexorably towards deflation. Only last week, we learned that the inflation rate across the zone ratcheted down to 0.3% last month, from 0.4% a month earlier, and a significantly lower figure than the market expected. It has been going steadily down for some time. Consumer inflation has not hit the ECB’s target level of 2% since the start of 2013. It has been falling steadily since it peaked at 3% in late 2011

It would be rash to expect that to change any time soon. The oil price has collapsed, and other commodity prices are coming down as well. That will all feed into the inflation rate. Retail sales are still weak, and unemployment is still rising. People who have lost their job don’t spend money — and companies don’t hike prices when the shops are empty.

Most economists will tell you that is very worrying — and that the ECB needs to act immediately to stop it getting worse. People will postpone buying anything because they think it will be cheaper next month. Companies will be reluctant to invest because they see their prices and profits going down. Confidence will be sapped, and the economy will suffer.

Even worse, the debts of peripheral eurozone countries will spiral out of control — because the amount they owe will remain the same, but there will be less income to service it.

But there is something odd about that analysis. The two countries with the worst price data are also the two countries doing best within Europe.

Just take a look at the figures.

In Greece, prices are falling at an annual rate of 1.7%. In Spain, they are falling by 0.4%. So presumably those are the two countries that have been hit hardest? Well, it has not quite worked out like that.

The fastest growing economy in the eurozone right now is none other than Greece. True, it is not exactly China, but it is expanding at an annual rate of 1.9% right now. And how about Spain? Its economy is also growing again, at an annualized rate of 1.6%.

By contrast, the economies where prices are still rising are not doing as well. Over in Germany, the supposed powerhouse of Europe, the inflation rate is still just in positive territory, at an annual rate of 0.5%. But growth in the third quarter was only 0.1%, narrowly avoiding recession. The same is true in France — inflation just about stayed positive, but growth has completely stalled.

So there does not appear to be much of a connection between rising prices and stronger growth. Nor do falling prices appear to be hurting very much.

So what is going on?

In reality, there is nothing terrible about prices falling. It is what happens in a competitive economy. Most of us like it when the stuff we buy gets cheaper.

There is no serious evidence to suggest that it deters people from buying things. If it did, no one would ever buy a television or a smartphone, because they know perfectly well that they can get a better one for less money next year. In reality, they buy plenty of both.

People buy things when they need them, taking price trends into account — after all, you can’t take either the money or the phone with you when you die, so you can’t postpone the purchase forever. Neither is there much evidence that it saps the confidence of companies. Again, if it did, no one would make any kind of consumer electronics. Businesses will invest where they think they can make money, and so long as costs are falling as well it is fine for prices to come down.

The threat to growth from deflation is wildly oversold. Indeed, for most of the 19th century deflation was completely normal — and that didn’t stop the industrial revolution in its tracks. Indeed, mild deflation may actually be helping Spain and Greece. As things get cheaper, consumers feel a bit more confident — and start spending again.

The one thing that is a problem is where there are high debts, as there certainly are across the eurozone. If prices fall, then those debt ratios are just going to get worse and worse. At a certain point, they will be unsustainable.

But in that case, surely the right response is to deal with the debt, not the deflation. Many eurozone countries have debts that they probably won’t ever be able to repay. If they thought inflation was going to deal with that for them, they will be disappointed. It isn’t going to happen.

By far the best thing for them to do now would be to restructure their debts. The ECB will throw everything it has at fighting deflation. But it is probably not going to work — and it might well be better if it didn’t.

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